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In November, Cavco Industries Inc. reported earnings for the second quarter of fiscal year 2024. This earnings report was a little shaky, due to unfavorable market conditions. Net revenue was $452 million dollars in the second quarter of FY24, compared to $577 million dollars in the second quarter of FY23 (21.7% decrease). Additionally, backlogs were $170 million at the end of the quarter, down $7 million from $177 million three months prior. Despite this, nearly $47 million dollars was returned to shareholders via share repurchases, showcasing the management’s strong capital allocation priorities that put shareholders first. While this short-term hiccup in earnings isn’t positive, management still remains committed to long-term business objectives, such as deepening distribution partnerships, developing innovative products and finance solutions, and improving the customer experience. When commenting on the quarter, CEO Bill Boor mentioned “Prospective homeowners have gotten no relief from the impact of rising interest rates and the affordable housing crisis is intensifying.” This further showcases the secular tailwinds positively affecting the manufactured and modular home construction market that Cavco Industries’ operates within. With these earnings results in mind, we took a closer look at some of the reasons why many investors are bullish on Cavco Industries Inc.
Cavco Industries Inc., headquartered in Phoenix, Arizona, is a leading manufacturer of factory-built homes in the United States. Founded on June 30, 2003, it stands as the successor corporation to previous Cavco entities that have been operational since 1965. The company specializes in designing and producing a wide range of factory-built homes, including manufactured homes, park model RVs, vacation cabins, and factory-built commercial structures. These homes are marketed under various brand names, such as Cavco, Fleetwood, Palm Harbor, and Solitaire, to name a few. Cavco operates 29 homebuilding production lines within the U.S. and two in Mexico, distributing its products through a network of independent and Company-owned retailers across 48 states and Canada, including 64 U.S. retail stores, 50 of which are in Texas. In addition to home manufacturing, Cavco’s finance subsidiary, CountryPlace Acceptance Corp., provides mortgage services and is approved by major national mortgage associations. Its insurance subsidiary, Standard Casualty Company, focuses on property and casualty insurance for manufactured homes, primarily serving the southwestern U.S. The company’s recent acquisition of Solitaire Homes has expanded its manufacturing capabilities into Mexico and bolstered its market presence, especially in the Southwest.
The manufactured housing industry, where Cavco Industries operates, offers affordable alternatives to traditional housing and appeals to a diverse demographic, notably those with incomes under $40,000, individuals aged 55 and older, and young adults, including Millennials. In 2022, manufactured homes accounted for about 14.9% of all new single-family home sales in the U.S., with a significant increase in shipments since 2009. The industry benefits from positive secular trends like the growing U.S. adult population, expected to expand by 8.3 million between 2023 and 2028, and the increasing interest from first-time homebuyers and older adults seeking energy-efficient, low-maintenance homes in planned communities. These factors, along with innovative production and engineering, position the industry for growth, despite its sensitivity to economic conditions such as employment levels, consumer confidence, and financing availability. The manufactured housing industry is highly competitive at both wholesale and retail levels, with management acknowledging that competitive factors are largely based on product features, price, depth of distribution, terms of retail customer financing, and service and quality reputation, among others. Cavco Industries competes well in these categories, despite the strong competition in the industry.
Cavco Industries’ management is solid, and their capital allocation priorities do a great job of aligning shareholder and management interests. Cavco Industries hasn’t paid out a cash dividend on the business’ common stock in two years, and there doesn’t seem to be any evidence of dividends returning in the near future. While some investors may not be fond of this, we believe that this is a great thing for a business like Cavco. Compounding businesses should always prioritize reinvestments back into the business (if they are able to generate a high enough return on capital), and then prioritize buybacks / dividends later. Since Cavco is currently trading at a low valuation based on our proprietary models (which we will touch on later), it also makes sense for them to repurchase shares, which they have done in the past and are still currently doing. In May of 2022, Cavco Industries’ Board of Directors approved a $100 million share repurchase program to be used to purchase its common stock. As we can see, management likes to repurchase shares to return value to shareholders, and they are very efficient at it. Buying back the business’ shares at cheap valuations greatly benefits shareholders, especially considering Cavco’s extremely low float (around 8.3 million shares outstanding).
Looking at management incentives and NEO compensation structure, we can see that management is incentivized well with a compensation structure that helps align shareholder and management interests. The components of the compensation structure include a base salary, annual short-term incentive cash compensation, and long-term equity compensation. The annual short-term incentive cash compensation is based on company and individual objective-based performance. The long-term equity compensation, on the other hand, is based on predetermined metrics like market share and relative total shareholder return. Not only does this equity incentive do an impeccable job of aligning management and shareholder interests (the relative total shareholder return metric ensures that both management and shareholders are on the same page when it comes to share price growth), it also does a great job of retaining executive talent over the long term, as executives build equity stakes in the business.
Cavco Industries is a very high quality business that is able to generate profit efficiently. The business currently operates at a LTM ROE of 20% and a LTM ROIC of 21.4%. With Cavco Industries operating at a WACC of 10.2%, the business currently operates at a ROIC to WACC ratio of around 2.1x, showcasing the business’ ability to generate returns on capital (which includes equity AND debt capital) far greater than the business’ weighted average cost of capital. Essentially, the business is earning more on each dollar invested than it costs to borrow or attract that dollar, showcasing efficient capital use and strong value creation for the business. Businesses that are able to generate high returns on capital are considered to be compounders, businesses that are able to rapidly compound earnings and intrinsic value over the long-term, handsomely rewarding shareholders.
Analyzing Cavco Industries’ income statement, we can see some stellar sustained growth in revenue, gross profit, and earnings within the last decade. Since 2014, the business has grown revenue at a CAGR of 14.9%, with gross profit growing at a CAGR of 18.1% in the same time period, showcasing strong top-line growth on the income statement. The high growth in gross profit can be attributed to expanding gross margins. In 2014, Cavco operated at gross margins of 19% of revenue, compared to today where the business operates at LTM gross margins of 23.9% of revenue. In terms of earnings, Cavco has grown EBITDA, EBIT (operating income), and EPS at CAGRs of 26.1%, 27.2%, and 30%, respectively. The growth in EBIT can be attributed to expanding EBIT margins (5% EBIT margin in 2014 compared to 13.8% LTM EBIT margin) and the fact that EBIT growth outpaces SG&A expenses in the long run (since 2014, SG&A has grown at a CAGR of 12.3%, compared to 27.2% EBIT growth in that same time frame, suggesting further EBIT margin expansion). Additionally, the growth in EPS can largely be attributed to share buybacks, along with high growth in net income (which we will touch on later). Since 2021, Cavco has decreased shares outstanding by nearly 10%.
Looking at Cavco Industries’ balance sheet, we can see that the business operates in solid financial health. The business currently holds around $391 million dollars worth of cash and equivalents and short term investments on the balance sheet, paired with total debt of $38.32 million dollars. Cavco Industries operated at net debt of -$353 million dollars, meaning that the business has $353 million dollars of excess cash on the balance sheet when compared to the business’ debt obligations. With so much excess cash on the balance sheet, Cavco industries has plenty of runway to reinvest that cash back into the business at favorable rates of return, allowing the business to continue to compound its intrinsic value and earnings over the long run. Additionally, this cash could be used to repurchase shares or to offer / increase a dividend. No matter what management decides to do, shareholders will be rewarded handsomely.
Analyzing Cavco Industries’ cash flow statement, we can see some stellar sustained growth in net income and free cash flow within the last decade, showcasing the business’ increased operational efficiency. Since 2014, Cavco Industries’ has grown net income at a CAGR of 31%, with free cash flow growing at a CAGR of 16.9% in that same time period. This growth in free cash flow can largely be attributed to incrementally expanding free cash flow margins. In 2014, the business operated at a free cash flow margin of 8.3% of revenue, compared to today where the business operates at a free cash flow margin of around 10% of revenue. If Cavco Industries’ is able to continue to incrementally expand free cash flow margins, it will act as a catalyst for future free cash flow growth, allowing the business to generate more and more cash that can be used for reinvestments back into the business, share repurchases, and/or cash dividends for shareholders.
After conducting a reverse discounted cash flow analysis, we can see that current share prices imply a -1% growth rate (CAGR) in free cash flow over the next ten years, using a discount rate of 10.2% (Cavco’s WACC) and a perpetuity growth rate of 3% (largely in line with US GDP growth). Cavco Industries’ is a wonderful business with no debt, piles of cash on the balance sheet, and strong top-line and bottom-line growth within the last decade. We believe that this valuation is insanely cheap, especially given the business’ last ten year growth rate in free cash flow (16.9%). While past performance is not indicative of future results, the business was able to expand free cash flow margins and rapidly expand free cash flow generation within the last decade, and we see no signs of this slowing down, especially to the level that the market expects. Using a conservative estimate of a 5% free cash flow CAGR over the next ten years, we get a share price of $442.26, implying a 45.48% return. This valuation is based completely on our proprietary models, and we encourage all investors to do their own due diligence when looking into Cavco Industries.
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This article was originally published on Quiver Quantitative
